AlphaLetters Paper Reviews – #8 & #9

From AlphaLetters, two more great quant working paper reviews:

Article 8.
Category: Calendar anomalies, weather anomalies, macro economic news announcements
Title: The Arrival of Information and Stock Market Anomalies
Author: Jeffrey R. Gerlach
Source: College of William and Mary working paper
Link: http://jrgerl.people.wm.edu/calendar%20anomaly.pdf

Summary:
This paper studies the relationship between macroeconomic news announcements and six stock market calendar/weather anomalies (the turn-of-the-month, monthly, rainfall, temperature, holiday and lunar effects) from 1990 – 2003. Key findings:

(1) Calendar/weather “anomalies” are largely due to returns on trading days when macroeconomic announcements were made
(2) five of the six anomalies disappear on ~2/3 of trading days when no such announcements were made

AlphaLetters comments:
1. Why important
We find this study forceful and may lay to rest many other similar calendar anomalies. It strengthens our view that each true anomaly should be backed by solid economic story (investor behavior). Things happen for reasons, and any quant strategy short of economic rationales may well be a mere manifestation of data mining.

2. Discussions
This paper covers six macroeconomic announcements rated most important by Briefing.com (Unemployment, CPI, Employment Cost, GDP, NAPM, and Retail Sales ) We believe the results may be stronger when one takes into account more announcements (e.g., the increasingly important housing data).

————————————————————————

Article 9.
Category: Merger & Acquisition advisors, insider information
Title: The Dark Role of Investment Banks in the Market for Corporate Control
Author: Author: Andriy Bodnaruk, Massimo Massa, Andrei Simonov
Source: Source: SSRN working paper
Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=966202

Summary:
This paper studies the insider role of the advisory bank in corporate Merger and Acquisition (M&A), key findings:
· The investment banking advisors to the corporate M&A bidders tend to hold stocks of the targets before the deal
· Such holdings in targets by advisors increase the likelihood of the bid and the target premium.
· Advisory banks indeed profit from such a position.
· A strategy that long target stocks held by bidders’ advisors generates a risk-adjusted return of ~4 % per month (48% annually), while a merger arbitrage strategy on average yields risk-adjusted return of ~0.5% per month(6% annually).

AlphaLetters comments:
1. Why important
This study asks a bold question and comes up with a surprising answer. If paper’s conclusion is proven to hold in the years since 2003 (the period cover in the paper ends at 2003), and given how active the M&A market is since 2006, we are perhaps looking at a promising strategy.

2. Data
1984-2003 data for 1,641 M&A events are from SDC. 13F filing ownership data are from Spectrum.

The matching of advisor and funds’ portfolio holding data are manually done. The stakes of bidder advisors in the target is the sum of portfolio holdings of the members of the financial conglomerate to which the advisor belongs. E.g., the stake of Morgan Stanley in a target includes the holdings of the all the hedge funds and mutual funds and other financial entities (e.g. commercial banks, pension funds, insurance companies) that are affiliated with Morgan Stanley.

3. Discussions
The robustness check in the paper is based on a rather small data size (1,641 events in 20 years), that should be a concern.

The economic rationale does not seem very straightforward and may be prone to data-mining. For the employees of an investment banking advisory, we could not see why they (as individuals) can benefit more from the success of a bid when other affiliated companies hold the target’s stocks. It seems to us that there is no such incentive system at conglomerate level to reward them.